They're local funds calling themselves private growth capital and they're on the hunt for Australian businesses with billion-dollar potential.
As featured in the Australian Financial Review on October 24th 2019, by Jemima Whyte
When it comes to turning paper wealth into cold, hard cash, it’s hard to go past Credible Labs’ Stephen Dash, the 35-year-old who this year sold his business for more than half a billion dollars to Lachlan Murdoch’s Fox Corp.
The deal netted Dash $55.25 million cash – plus he keeps a 33 per cent stake in the newly merged company, giving him an estimated personal fortune of $265 million and placing him 17th on the Australian Financial Review Young Rich List. It’s also delivered one of his major backers, Regal Funds Management, a healthy return for one of its biggest early investments.
But for Regal’s Ben McCallum it was the deal that nearly never happened.
In 2016, McCallum, now also 35, had just established Regal’s emerging companies fund – a pool of money to invest in businesses that are on the cusp of listing on the ASX. He was a big believer in Credible, which operates an online marketplace for student and personal loans and, more recently, mortgages, and he wanted to cut a $US5 million cheque for a minority stake, half of Credible’s new funding.
The problem? He’s known Dash since they were both investment banking graduates in Sydney. The two regularly caught up, as friends, over beers at North Bondi RSL. McCallum had even taken Dash’s job with investor Mark Carnegie when Dash was heading offshore, and McCallum was looking for a job back home.
“It was catch-22,” says McCallum: he had complete faith he knew management, but felt compelled to repeatedly crawl all over the numbers to make sure his team and investors understood he wasn’t simply backing a mate – and perhaps convincing himself. No one likes mixing friends with money.
In just four years, that dynamic has reversed. Now, with so much money washing around the private markets and frequently zoning in on the same targets, it’s often the relationship that gets the investor in the door and seals the deal. It’s both what you know, and who you know.
Back in 2016, Regal’s emerging companies fund – which has backed businesses ranging from Adobe disruptor Nitro, family-tracking app Life360 and Avoka Technologies – was a rarity.
Three years later it has $400 million under management and is just one of a growing group of local funds on the hunt for private businesses that have the potential to become billion-dollar-or-more companies. Sinking their money into these funds are some of the country’s richest families.
As well as Regal, the funds include Rich Lister Alex Waislitz’s Thorney Investments, another investor in Credible and also an early investor in buy now, pay later juggernaut Afterpay where the surging share price has propelled chief executive Nick Molnar into 66th spot on the 2019 Young Rich List.
TDM Growth Partners is a Sydney-based player that’s backed terminals provider Tyro Payments, tipped to float this year worth more than $1 billion, as well as retailer Baby Bunting, employee feedback system Culture Amp and others.
And just down the road in Sydney’s prestigious Macquarie Street is Alium Capital Management, which has invested in 45 businesses, including Koala Mattress, Nitro and Spriggy.
These funds call themselves private growth capital, or sometimes “crossover funds”, and are staking out a sweet spot. They focus on companies that have proved they can generate meaningful revenue, and that need more capital to get to a public float.
As a result, they’re playing on a different field from both traditional venture capital, which invests smaller licks of money at an earlier stage, as well as private equity, which looks for more established businesses and swallows them whole.
Outsiders call it souped-up venture capital. But really, this new patch of finance is so hot that the boundaries as to who does what are already getting blurry.
Low yields and interest rates are turbo-charging the space. Right now, this is the segment of the market where the action is and where the fast money is playing. Often, the funds get on board at the last stop, pre-IPO round, where funds buy into companies with a planned exit in 12 months or so, usually via a sharemarket float.
The key skills? Sifting through dozens and dozens of founder-led private businesses, sorting the wheat from the chaff; avoiding the dogs and looking for the founders who really have what it takes to scale up and make it big.
These funds are the ones – to borrow the words of Rajeev Gupta, the co-founder of Alium Capital – that want founders to dream more, take on a little bit more risk. And hopefully, they’ll all get richer along the way.
The irony of the Financial Review Young Rich List – and rankling irritation for many who find themselves on it – is that very often, these business builders aren’t really rich at all. These are people who have created fast-growing, successful companies, often at great personal cost. But their wealth is tied up in the valuation of a business that is tricky to sell.
Founders don’t like to sell shares in their baby, especially when it’s growing hyper-quickly and the best days are yet to come. For one, they don’t want to be diluted and left with less of the equity should the day for hitting paydirt eventually arrive. For another, potential outside investors become uneasy when founders start taking any real money off the table. And until they’ve sold, a paper valuation is just that: paper.
Koala Mattress co-founder Mitch Taylor started the company with Byron Bay childhood buddy Dany Milham in 2015, self-funded and, a bit later, with a $100,000 investment from cricketer Steve Smith. Now, the business is worth $150 million, and it has propelled Smith’s wealth to $31 million. Taylor, aged 31 and in the 63rd spot on the Young Rich List, says being a founder is exhilarating, but also lonely, particularly in the so-called “bootstrapping” phase. And few people understand it.
“The first couple of years at Koala I was riding a bike, I couldn’t afford a decent car because every cent was needed in the business to continue growing it. It was funny, I was on the Young Rich List but couldn’t even own a car,” he says, adding it didn’t help that many of his school friends expected him to always pick up the drinks tab as well.
Bootstrappers rely usually on personal income and savings, sweat equity, lowest possible operating costs, fast inventory turnaround, and a cash-only approach to selling.
Half of the entrants to the Financial Review’s Young Rich List have never taken external funding, apart from bank debt. That could reflect the number of sports stars and perhaps also the strong showing of the tech sector, which often requires less investment.
Equally, it might raise questions about some of the unrealistic valuations at which the founders would like to sell a stake in their business.
“They used to say in the old days, revenue is for vanity, profit is for sanity ... ultimately that is right,” Thorney Investments’ Waislitz says. “But on the way through you can create tremendous value, as we’ve seen.” Right now, the market is very aware of this adage.
Uber was possibly the hottest company in the world, until it listed. Both it and fellow ride-share business Lyft are both trading well below their float prices. In September, VC monster SoftBank pulled the upcoming float of WeWork, slashing its valuation and pushing out its pot-smoking founder, Adam Neumann.
Suddenly a lot of people are raising tough questions about the lofty valuations for companies in the private market. This new scepticism underscores even more the need to partner with a savvy financial backer. It’s a two-way hunt: funds are looking for the real thing; and so are the business builders.
Alium’s Gupta says some founders are so focused on building up the business for an IPO they don’t consider seeking earlier funding. Until it began to formalise, this pool of private growth capital wasn’t widely known about, or easy to find, unless it came knocking. When Dash and McCallum were having beers in Bondi, there weren’t many local funds backing companies at its stage in the lifecycle, and many were heading straight to the United States.
Indeed Koala, before taking investment from Alium, nearly closed a deal with a US private equity firm, before Taylor and Milham got last-minute cold feet about the equity stake they were giving up.
They abandoned the deal, and were later introduced to Alium by a venture debt fund (also a newish pool of capital) which structured a deal that enabled the founders to retain control in a relatively straightforward preference-share transaction.
Tyro, tipped to be one of the year’s biggest tech floats, didn’t even consider local funding in Australia. It had been planning to raise growth capital in the US when Hamish Corlett of TDM got wind of the raise, and swooped. The fund had been eyeing the company for some months, and moved quickly to make a better offer.
Atlassian, of course, is the one that got away, having tapped private markets in the US ahead of its eventual listing on the NASDAQ. Credible’s Stephen Dash, who’s now based in the US, says the Australian funding market is still minuscule compared with money washing around the private growth capital sector in the States, but it’s growing quickly.
“It’s not Silicon Valley, but there’s now a decent early-stage funding market in Australia,” Dash says. Not that capital is the only thing founders are looking for. They need market nous, and sometimes emotional support as well.
These days, it’s rare an investor meets a founder who hasn’t already met other growth funds. And more are considering taking private money to grow. Yet unearthing a company to invest in is only half the challenge.
Now, the real edge often lies in convincing the founder that your input will be far more valuable than cash alone. So what happens if you haven’t met each other as investment banking grads?
These days, more and more companies are being pitched directly to these new funds – and their offshore counterparts as well.
TDM’s Corlett says the fund is seeing five to 10 times the number it saw in the 18 months before; while Alium’s Gupta says it’s rare to find a local target another fund hasn’t met. Four years ago, the odds were one in two. Clearly, that makes it harder to find the right investment.
Australia’s private growth capital funds have slightly different criteria for the types of companies they are looking for. But they overlap: they’re all on the hunt for high-growth (20 per cent is bottom of the heap), scalable business models, and an impressive founder and management team. Increasingly, what differentiates one offer of equity from another is the people behind it. And those relationships can be years in the making.
n the case of Alium and Koala, it’s another deal that almost wasn’t. Alium, which has invested in 45 companies and says it has returned 80 per cent to date since 2016, says one in one hundred founders is worth backing.
“We said ‘we’re not interested, who wants mattresses?’,” Gupta says. “But we were blown away when we met them, by their understanding of the market they were disrupting with an asset-light model.”
That’s just the first step. Each fund says there’s no way you can go ahead with an investment unless you back the founder. That’s not always easy to call, and can be easy to get wrong. “Being an entrepreneur is a bit of a crazy thing to do, so you have to be a bit crazy,” Regal’s McCallum says. But when it works, it really works.
“It’s like having financial uncles,” says Taylor of the Alium Capital team. Gupta and Taylor say they text daily, meet regularly, talk about everything – from business to family – and even share leadership coaches.
TDM’s Hamish Corlett agrees that relationships are everything. He has at least a handful of companies he wants to meet quarterly, to offer suggestions and get to know the founders, despite not yet being invested. The key trait he’s looking for in a founder is grit.
“It’s the toughness that makes them outstanding,” he says, noting that any business will need time in the trenches.
“No matter how good an Atlassian or Canva or Culture Amp are, these businesses are growing incredibly quickly. Behind that Excel spreadsheet, you go through existential ups and downs. It comes down to that toughness, the ability to pick yourself up … and ensure underlying it is a passion for the mission.”
Corlett regularly met Didier Elzinga at Culture Amp, talking everything from business to family and more. This long courtship is not only about getting to know one another, it’s about demonstrating that both parties can listen and work together as well. It’s why Thorney’s Waislitz often gives office space to fledgling businesses such as Mesoblast.
McCallum says his fund has recently narrowed its focus to investments that will list within 12 months, though there is always potential for the timetable to slip. That’s because Regal’s edge is in listed markets, he says. The mantra at Regal is to back a company pre-IPO, and take it all the way to the large cap fund. At least, that’s the ambition.
Getting in early is about more than the return, McCallum says. There’s no insider information restrictions in private markets, and the Regal team soaks up as much information as it can, including getting to really know the founders, before the company goes into blackout pre-IPO. It means private investors can benefit by understanding the business better than counterparts who only invest in listed companies.
That’s one reason, McCallum says, the fund was confident Credible was the right bet: even while shares traded below the IPO issue price. Indeed Regal was so sure the market had it wrong, it bought more.
For every Credible, there are many more that go nowhere. The path to profitability or growth can be longer than expected, the team less robust than anticipated or the business model not quite what was hoped for.
It’s easier to hide in private markets. A smaller-than-expected raising can be dressed up; a founder sell-down explained as a liquidity event; venture debt can be introduced if equity isn’t available. All of that is why down rounds – when the next round of capital is raised at a lower valuation than the previous rounds – are rare.
A public listing is a sure-fire step on the path to delivering the real money – for a founder to actually get hard cash into their hands. But as the market gets increasingly jumpy, isn’t that a risky way to deliver value? Can the floats really keep coming?
“I smell it ... there’s going to be a tonne more listings,” Gupta declares, confident the ecosystem is serving up public market-ready companies and investor demand is real. After all, just 7 per cent of the index is tech, compared with 54 per cent in the US.
But an IPO is also an acid test. “The public [share]market is the true test of the value of a company over the long term,” says Corlett. “There’s power in the accountability of being a public company and we think it can bring out the best in companies and management teams.”
Moreover, it’s liquid: the valuation applied to the company is tradeable, and measurable. He’s enthused about how many companies are now reaching a point where they turn to growth capital domestically, rather than head offshore.
But there’s also an overriding sense of caution. “The momentum trading and the fear of missing out [FOMO] dynamic is as prevalent if not more prevalent in the private market, as it is in the public market,” Corlett says, speaking slowly to add emphasis.
“FOMO in the private market is on steroids ... there’s a huge weight of money. With the prevalence of structured instruments and incentives to deploy money, there are certainly ingredients that can lead to some wacky situations.”
Australia hasn’t seen many of those yet, he adds. It helps that the structures many local growth funds use are different to those in the US, but you can’t entirely structure away greed.
Meanwhile due diligence times are shrinking, and the deal flow is growing. Backing a founder and company takes as much skill as building one. If a clean-out comes, they’ll all be under scrutiny.
The author has investments with TDM.
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